Chapter 18

Three Organizations of a Company

1. Sole Proprietorship 2. Partnership 3. Corporation: dominant form of business organization Accounting for most transactions (with capital as an exception) is the same regardless of the type of organization

Deficit

A debit balance in retained earnings

Share Buybacks

Decreasing the amount of shares in the marketplace *help support the price of remaining* shares, requisition of a company's own shares *does not create an asset*. Two ways of accounting for buybacks: 1. The shares can be *formally retired* 2. The shares can be called *treasury stock*

Statement of Shareholder's Equity

Reports the transactions that cause changes in shareholder's equity account balances

The Model Business Corporation Act

Serves as the model for the corporation statutes in each state

Transactions involving treasury stock have __________ impact on the income statement.

Treasury stock transactions have NO IMPACT on income statement

Fractional Shares

When a stock dividend or split results in some shareholders being entitled to a fraction of whole shares. Cash payments are usually made to shareholders for fractional shares and called "in lieu of payments"

Shareholder's Equity

*"Net Assets"* Made up of the accounts that represent *ownership interests* of shareholders. The residual amount that is left over after creditor claims have been subtracted from assets. Basic Equation: Assets - Liabilities = Shareholder's Equity

Retained Earnings

*Beg. Retained Earnings + Net Income - Cash & Stock Dividends = Ending Retained Earnings* Represents earned capital. Accumulated on behalf of shareholders and reported as a single amount

Comprehensive Income

*Total non owner change in equity for reporting period* Provides a more expansive view of the change in shareholder's equity than traditional net income. Includes n*et income as well as other gains, losses, and adjustments* that change shareholder's equity.

Shareholder's Equity Balance Sheet Presentation

+ Preferred Stock + Common Stock + Paid-in Capital in Excess of Par- Preferred Stock + Paid-in Capital in Excess of Par- Common Stock TOTAL Paid in Capital + Retained Earnings Less: Treasury Stock =Total Stockholder's Equity

Advantages and Disadvantages of a Corporation

- Limited Liability (separate legal entity, owners not responsible for its debt) - Ease of Raising Capital (ownership interest is easily transferred, shareholders do not have a mutual agency relationship) - Disadvantages: extensive government regulation, subject to double taxation (taxed on earnings that are again taxed when dividends are distributed to owners)

Cumulative vs Noncumulative Preferred Shares

1. *Cumulative*: Typically, if the specified dividend is not paid in a given year, the *unpaid portion must be made up for in a later dividend* before any common stock dividends are paid. ("*Dividends in arrears*") 2. *Noncumulative*: If specified dividend is not paid in given year it *does not ever need to be paid*

Participating Shares vs Nonparticipating Preferred Shares

1. *Participating*: Preferred shareholders may receive additional dividends beyond the stated amount (pro rata allocation based on common and preferred shares outstanding) 2. *Nonparticipating*: Preferred shareholders' dividends are limited to the stated amount

Hybrid Organizations

1. *S Corporation* (combine *regular corporations and partnerships*) 2. *Limited Liability Company* (owners not liable for debt of company except the the *extent of their investment*, *no limit to number* of owners, all members can be *involved in managing*) 3. *Limited Liability Partnership* (*similar to LLC* but doesn't offer all the liability protection of an LLC)

Types of Gains and Losses Included in Comprehensive Income

1. Net holding gains (losses) on available-for-sale investments in debt securities 2. Gains (losses) from amendments to post retirement benefit plans 3. Deferred gains (losses) on derivatives 4. Adjustments from foreign currency translation

Types of Corporations

1. Not-for-Profit (may be owned by public sector or a government unit) 2. For Profit (may be publicly held and owned (on an exchange or over-the-counter) or privately held)

Four Classifications Within Shareholder's Equity

1. Paid-in Capital 2. Retained Earnings 3. Accumulated Other Comprehensive Income 4. Treasury Stock

Rights of Common Shareholders

1. Right to *vote on matters*, each share owned represents one vote 2. Right to *share in profits* when dividends are declared, percentage of shares owned determines amount 3. Right to share in the *distribution of assets* if the company is liquidated, percentage of shares owned determines share of assets after creditors and preferred are paid Sometimes also given *preemptive right* which is the right to maintain one's percentage of share ownership when new shares are issues

Two Sources of Ownership Interests

1. The amounts *invested* by shareholders in the corporation (*Paid-in Capital*) 2. The amounts *earned* by the corporation on behalf of its shareholders (*Retained Earnings*)

Rights of Preferred Shareholders

1. Typically have *preference to a specific amount of dividends* (stated as dollar amount per share or % of par value) and receive dividends before common shareholders 2. Customarily have *preference as to distribution of assets* over common shareholders in the event of liquidation Sometimes also given *right of conversion* which allows them to exchange preferred stock for common stock at a specified conversion ratio. Or given *redemption privileges* to redeem shares for a predetermined price

Payments made by a corporation to retire its own shares is viewed as...

A distribution of corporate assets to shareholders

Privately held companies shares are held....

By only a few individuals and are not available to the general public

Companies declare stock dividends so that they can..

Capitalize Retained Earnings

Paid-in Capital

Consists primarily of 1. amounts invested by shareholders when they purchase shares of stock from the corporation or arise from the 2. company buying back some of those shares or 3. from share-based compensation activities

Dividend

Distributions of assets that the company has earned on behalf of its shareholders. If dividends are made that exceed the amount that the company has earned, management is, in effect, returning shareholders a portion of their investment rather then providing a return on their investment

Cash Dividends

Dividends paid to shareholders in the form of cash. 1. When Dividends are *Declared*: We *reduce retained earnings* (debit) and *record a liability* (cash dividends payable) 2. When Dividends are *Recorded*: *No entry* is made, date stated as to when determination of who will receive dividends will be made 3. When Dividends are *Distributed*: Debit liability account previously credited and credit common/ preferred stock

Journal Entry for Shares Issued for Cash

Dr. Cash (number of shares x price per share) Cr. Common/ Preferred Stock (number of shares x par value) Cr. Paid-in Capital in excess of par - common/preferred (remaining amount)

More than One Security Issued for a Single Price

Each form of stock issues (preferred and common) is accounted for at the market price of that stock, if only one market price known, deduct from total price of transaction (In the event that total price is not equal to the sum of the two market prices, allocate between the two securities in proportion to relative market values)

"Paid-in Capital- Shares Repurchased"

Has a normal credit balance. Can only be *reduced (debited) to the extent of its current credit balance*. If a difference still exists beyond this amount, the *excess is debited to Retained Earnings*

Reverse Stock Split

Occurs when a company decreases, rather than increases, the amount of shares outstanding. No journal entry is necessary but this action increases the price per share.

Stock Split

Reason for issuing stock dividend is usually to induce the per share market price decline that follows. Doing this *increases the stock's marketability* The par value is divided by the amount of the stock split (2 for 1 doubles shares outstanding and cuts par value in half) *Requires no entry unless effected*

Share Issue Costs

Reduce the net cash proceeds from the sale by reducing the amount allocated to paid-in capital in excess of par

Property Dividends

Refers to when non cash assets are distributed as dividends. The *fair value* of the assets to be distributed is the amount recorded for a property dividend (FV measured at date of declaration) 1. To *Declare*: FIRST increase (decrease) investment account by any gain (loss) on appreciation (depreciation) in the investment to make book value equal fair value THEN debit retained earnings the fair value amount of the asset and credit "property dividend payable" 2. To *Record*: No entry 3. To *Distribute*: Debit "property dividends payable" and credit the investment account the fair value amount

Accumulated Other Comprehensive Income

Reported in the shareholder's equity section of balance sheet. The amount of other comprehensive income (non owner changes in equity other than net income) accumulated over the current and prior period

Treasury Stock

Shares repurchased and not retired, have no voting rights and do not receive dividends. Equivalent to authorized but unissued shares. Accounted for by reducing shareholder's equity by *debiting Treasury Stock (a contra account)* the amount of acquiring the shares; which is later reversed when shares are resold.

Retired Stock

Shares repurchased that are not designated as treasury stock. *Decreases cash and shareholder's equity* and reduces company size.

Stock Dividend

The distribution of additional shares of stock to current shareholders of the corporation. *Does not effect either the assets or liabilities* of the firm (unlike property and cash dividends). 1. Small Stock Dividend (less than 25%) 2. Large Stock Dividend (more than 25%)- *AKA Stock Split*

Small Stock Dividend Accounting Treatment

The fair value of additional shares distributed is transferred and reclassified from retained earnings (debit) to paid-in capital in excess of par. Dr. Retained Earnings (Amount x Price) Cr. Common/ Preferred Stock (Amount x Par) Cr. PIC in excess of par- Common/ Preferred Stock (Amount x (Price - Par))

Journal Entries for Retired Stock

To Buyback Shares: Dr. Common Stock (Amount of Shares x Par Value) Dr. Paid-in Capital in Excess of Par- C/S (Dr. Retained Earnings if Insufficient Credit Funds in PIC- SR) Dr./ Cr. Paid-in Capital- Shares Repurchased (Difference) Cr. Cash (Amount of Shares x Repurchase Price) To Reissue: (Seen as New Shares) Dr. Cash Cr. PIC in Excess of Par- C/S Cr. Common Stock *After shares are formally retired, any subsequent sale of shares is simply the sale of new, unissued sales*

Journal Entries for Treasury Stock

To Buyback Shares: Dr. Treasury Stock (Amount of Shares x Price Shares Were Sold) Cr. Cash To Reissue Treasury Stock: Dr. Cash (Amount of Shares x Sale Price) (Dr. Retained Earnings if Insufficient Credit Balance in PIC) Dr/Cr. Paid-in Capital- Shares Repurchases (Difference) Cr. Treasury Stock (Amount of Shares x Original Sale Price) *Treasury stock repurchase and its subsequent resale are seen as a single transaction*

Stock Splits Effected in the form of a Large Stock Dividend

To avoid changing the per share par value of the shares, the stock split is referred to as "stock split effected in the form of a stock dividend" (or stock dividend). Dr. Paid-in Capital in Excess of Par- Common (Preferred) Stock Cr. Common Stock *OR* Dr. Retained Earnings Cr. Common Stock

Ex-Dividend Date

To be a registered owner of shares on the date of record, shares must be purchased before this date. Date usually 2 business days before date of record and is the first day the stock trades without the right to receive the declared dividend. *Market price of share usually decline by dividend amount on this day*

Shares Issued for Non Cash

Transaction should be accounted for at *fair value* (ex the amount of cash that would have been paid to purchase the asset/ service) or the *market price of the shares* Debit the expense account, asset account, etc and credit the same 2 accounts as cash transaction

Liquidating Dividend

When dividend exceeds the balance in retained earnings, the excess is referred to as a liquidating dividend. (May occur when company is being liquidated) Any portion of a dividend not representing a distribution of earnings should be debited to *additional paid-in capital* rather than retained earnings

Accounting for Retired Shares

When shares are retired, we reduce the same accounts that were increased by the issuance of the shares by the amount that the shares were originally sold for regardless of the retirement price The difference in the cash paid to buy the shares and the amount they were originally sold for effects whether you debit or credit the "paid in capital- shares repurchased" account